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On the Distributional Effects of International Tariffs

What are the distributional consequences of tariffs? We build a trade model with incomplete asset markets and households that are heterogeneous in their income, wealth, and labor skill. We increase tariffs by 5 percentage points and examine several budget-neutral fiscal policies for redistributing tariff revenue. Without redistribution, tariffs hurt all households, but higher tradables prices disproportionately harm the poor and the ensuing decline in the skill premium disproportionately harms the skilled. With redistribution, lowering the labor income tax leads to lower economic activity but higher average welfare relative to lowering the capital income tax; nevertheless, both policies reduce average welfare with retaliatory tariffs. Finally, when tariff revenue is rebated to households as lump-sum transfers, tariffs can be welfare improving even with full retaliation.

Keywords: tariffs, inequality, consumption, welfare, taxation.
JEL Classification: E21, F10, F62, H21.

Suggested citation: Carroll, Daniel, and Sewon Hur. 2020. “On the Distributional Effects of International Tariffs.” Federal Reserve Bank of Cleveland, Working Paper No. 20-18.

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